Heartland Financial USA Inc (HTLF) 2013 Q3 法說會逐字稿

Greetings, and welcome to the Heartland Financial USA Incorporated third-quarter 2013 conference call. This afternoon, Heartland distributed its first-quarter press release, and hopefully you have had a chance to review the results. If there's anyone on this call who did not receive a copy, you may access it at Heartland's website at www.htlf.com. With us today from management are Lynn Fuller, Chairman, President, and Chief Executive Officer; Bryan McKeag, Chief Financial Officer; and Ken Erickson, Executive Vice President and Chief Credit Officer. Management will provide a brief summary of the quarter, and then we will open up the call to your questions.

Before we begin the presentation, I would like to remind everyone that some of the information management will be providing today fall under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, I must point out that any statements made during this presentation concerning the Company's hopes, beliefs, expectations, and predictions of the future are forward-looking statements, and actual results could differ materially from those projected. Additional information on these factors is included from time to time in the Company's 10-K and 10-Q filings, which may be obtained on the Company's website or the SEC's website.

(Operator Instructions). As a reminder, this conference is being recorded.

At this time I will now turn the call over to Mr. Lynn Fuller of Heartland. Please go ahead, sir.

Thank you, and good afternoon. We certainly appreciate everyone joining us this afternoon as we review Heartland's performance for the third quarter of 2013. For the next few minutes, I'll touch the on highlights for the quarter, and will then turn the call over to Bryan McKeag, Executive Vice President and Chief Financial Officer, who will provide further detail on Heartland's quarterly financial results. And then Ken Erickson, our Executive Vice President and Chief Credit Officer, will offer insights on credit-related topics.

Heartland's earnings fell short of our expectations for the third quarter, with net income of $6.8 million or $0.38 per diluted common share, compared to net income of $13.6 million or $0.75 per diluted common share for the third quarter last year. Heartland's year-to-date net income of $28.9 million or $1.63 per diluted common share compares with $40.4 million or $2.24 per common share for the first three quarters of 2012. Book value and tangible book value per share ended the quarter at $18.58 and $16.63, respectively.

Well, notwithstanding a down quarter of earnings, several aspects of Heartland's performance were positive, beginning with net interest margin, which increased to 3.81%, a 10 basis point gain over the previous quarter, and reversing a four-quarter downward trend. Margin improvement was a result of the combination of loan growth, improved yields on securities, and some reduction in our cost of funding.

We were also pleased to see loan growth during the quarter of $69 million, of which is nearly 10% annualized. The growth was broad-based, with increases in commercial, residential, and consumer business lines. Quality loan growth remains one of our highest priorities. And as we enter the fourth quarter, the pipelines look strong at each of the Heartland banks. Also favorable is year-to-date return on average common equity of 11.63%, and 12.97% on average common tangible equity. For the third quarter, return on average common equity was 8.38%, falling short of our acceptable 12% to 15% range.

Heartland's quarterly results were negatively affected by a jump in provision expense to $5.1 million compared to $1.9 million for the previous quarter. Nonperforming assets also increased, ending the quarter at $80.3 million, representing 1.62% of total assets. We don't believe this increase represents a trend, and in a few minutes Ken Erickson will provide more detail on our nonperforming, along with other credit administration topics.

Moving on to the balance sheet, total assets ended the quarter at $4.9 billion. As you may recall, Heartland is a participant in the US Treasury's Small Business Lending Fund. I'm pleased to report that since Heartland's qualifying loan balances exceeded our 10% growth goal, the dividend rate on the preferred shares is now locked in at 1% until March of 2016. Consistent with our stated strategy, we continue to shift dollars out of securities into quality loans, with securities now representing 29% of total assets, and that's down from 32% in the second quarter. Our objective remains to convert $20 million in monthly cash flow from our securities portfolio into quality loans.

Moving on to deposits, we were pleased to see $84 million in growth during the quarter, representing an annualized growth rate of 9%. We also continued to see improvement in deposit mix, with noninterest demand deposits and low-cost savings products representing 27% and 52% of total deposits, respectively. In terms of capital, our tangible capital ratio improved to 5.78% for the quarter, and that's up from 5.69%.

Moving on to the income statement, noninterest income of $72 million year-to-date is down from the previous year as a result of the slowdown in mortgage originations, which we believe is pretty consistent with the industry. However, other fee income areas such as service charges, loan servicing income, trustees, and brokerage all saw double-digit increases. Responding to the slowdown in residential refi activity, our Heartland mortgage unit continues to increase its production capabilities both within and outside our current footprint. We recently opened a new loan production office in Milwaukee, Wisconsin, and are currently in the process of expanding into the Portland, Oregon; Seattle, Washington; and Kansas City, Kansas markets.

Year-to-date mortgage loan originations of $1.3 billion are slightly ahead of the 2012 year-to-date production. We estimate that 2013 total production will come close to last year's production of $1.6 billion. Currently, our production continues to shift towards purchase originations, with current purchase originations now at 66% compared to 36% for the same quarter last year. Noninterest income expenses were flat year-over-year and down 3% from the second quarter of 2013. The improvement is largely related to the reduction of human resource expenses associated with the decline in residential mortgage volume, and losses on repossessed assets. Expansion of our banking franchise through M&A remains a high priority for Heartland. Last week we completed the purchase of Kansas-based Morrill Bancshares, and welcome our new associates from Morrill & Janes Bank and Trust Company into the Heartland organization.

We're delighted to serve the Kansas and Missouri markets, and see further M&A opportunities in this region. Along with Morrill & Janes, Heartland also gained a new director. As the Bank President and CEO, Kurt Saylor has joined the Heartland Board of Directors. Heartland now serves 10 states with 78 banking centers, and assets of over $5.7 billion. Going forward, we would like to announce at least one more acquisition yet this year.

I'm pleased to report that at its October meeting, the Heartland Board of Directors elected to maintain our dividend at $0.10 per common share, payable on December 6, 2013. I'm pleased to say that Heartland, since its inception in 1981, has either increased or maintained its dividend stable.

Last month, Heartland also welcomed two new executives to our senior management team. First was Mark Murtha, Executive Vice President of Human Resources, who brings 11 years of experience at a Midwestern peer bank, and a total of 20 years of HR leadership to our team. Next, the gentleman you are about to meet on this call is Bryan McKeag, Executive Vice President and Chief Financial Officer. Bryan has served as controller and principal accounting officer at a top-50 regional bank, and brings 21 years of banking and finance management experience.

Before turning the call over to Bryan, I want to recognize and thank Dave Horstmann, who stepped up and served as our Interim CFO for Heartland since June. Dave's leadership of our finance team was invaluable, and we are indeed fortunate to have his continuing experience.

I'll now turn the call over to Bryan McKeag for more detail on our quarterly results. And then Bryan will introduce Ken Erickson, who will provide commentary on credit topics.

Bryan?

Thanks, Lynn, and good afternoon. Over the next few minutes I'll share some details on the main performance drivers of our third-quarter results and provide updates on some of our key 2013 operating metrics. I'll start with the balance sheet. As Lynn already alluded to, the investment portfolio declined $132 million, ending the quarter at just over $1.4 billion. The tax equivalent yield on the portfolio increased 19 basis points during the quarter to 2.69%, reflecting both the impact of lower yielding portfolio runoff and lower premium amortization due to slowing prepayment speeds on our mortgage-backed securities. These slowing prepayments speeds have also caused the duration of the portfolio to increase slightly to 4.45 years, up from 4.3 years at the end of 2012.

Moving on to the loan portfolio, the balance of loans held for sale declined $27 million or approximately 30% from the prior quarter, which nears the decline we saw in mortgage loan production. Loans held to maturity increased by $69 million this quarter, bringing the total year-to-date growth to $80 million. Based on current pipelines and activity, we anticipate a similar level of growth in the fourth quarter, which would bring our full-year growth to about $150 million or 5%.

Shifting to the income statement, net interest margin improved to 3.81% for the third quarter compared to 3.71% in the prior quarter. This increase reflects the previously mentioned 19 basis point pickup in investment yields, a reduction in liability interest cost of 5 basis points, offset by a 7 basis point decline in loan yields. More importantly, net interest income grew in the third quarter, increasing to $39.9 million from $38.9 million in the second quarter. This is the sixth consecutive quarter of increasing net interest income, and supports our view that margin dollars should continue this trend of slow growth. Of course, this depends upon our ability to increase loan outstandings.

As I stated, we continue to make progress in reducing our interest costs, which declined 5 basis points this quarter. Our greatest opportunity continues to be in time deposits, with $75 million to $100 million maturing per quarter over the next several quarters, at average rates ranging from 1.3% to 1.5%. We are experiencing a 70 to 80 basis point reduction in the cost of these certificates as they mature. Ken Erickson will provide information on the provision for loan and lease losses, which totaled $5.1 million for the quarter. Net interest income totaled $20.7 million for the third quarter, down $4.1 million compared to the prior quarter. The decrease was driven by a $3.8 million decline in mortgage banking income and a $1.1 million decrease in gain on sale of securities. Offsetting these declines were continued increases in other fee income categories.

The mortgage income banking income decline of $3.8 million, or about 40%, was almost entirely due to a $3.7 million reduction in gain on sales loans, which was $5.3 million this quarter compared to $9.1 million in the prior quarter. We saw margins on sold loans decline by 15% to 20% this quarter, and mortgage loans originated and sold of $337 million were down approximately 25% from the prior quarter. Since quarter-end, pipelines have improved slightly as rates have eased; and, therefore, we anticipate that mortgage loans originated and sold to the secondary market in the fourth quarter should be similar to this quarter.

Security gains totaled $1.1 million for the quarter. Most of the gain was related to the sale of a limited partnership investment, with a smaller portion related to sales of SBA floating-rate and reverse-mortgage securities.

Switching to non-interest expense, we saw a decrease of $1.6 million quarter over quarter. The largest component of this decrease was a $1.4 million decline in losses on repossessed assets. Ken Erickson will provide more detail on this item in his comments.

Salary and benefit costs declined $700,000 quarter-over-quarter, primarily as a result of lower commissions associated with the decline in mortgage production. The effective tax rate for the quarter was 18%, down from 27% in the prior quarter, as pretax income declined while tax-exempt income increased. We feel it is appropriate to expect the tax rate to return to the 28% to 30% range going forward.

In summary, I would provide the following, relative to anticipated performance for the fourth quarter. Loan growth is expected to be similar to Q3, and will continue to be funded by investment portfolio cash flow. Net interest income should continue a slow increase, with the net interest margin remaining fairly stable. Gain on sales loans will be at lower margins, with loan production expected to be similar to the third quarter. Finally, the full benefit of the recently completed Morrill & Janes merger will not be evident until the systems are converted in the second quarter of 2014. However, the fourth quarter impact of the merger is expected to increase loans by $380 million; increase investments by $340 million; increase deposits by $640 million; increase the number of shares outstanding by 1.4 million; and with transaction costs and purchase accounting adjustments in Q4, the EPS impact should be slightly negative by maybe $0.02 or $0.03.

In closing, I would like to add that I'm really thrilled to be part of Heartland's executive management team, and want to thank everyone at Heartland and our member banks for being so welcoming and helping to make my transition as smooth as possible.

With that, I'll turn the call over to Ken Erickson, Executive Vice President and Chief Credit Officer.

Thank you, Bryan, and good afternoon. The first thing I would like to draw attention to is the change shown in nonperforming loans and other real estate owned. Including those assets covered by loss share agreements, nonperforming loans increase by $6.3 million in the third quarter. We had one loan of $13 million that was moved to nonperforming this quarter, which I'll elaborate on in a minute. Excluding this loan, the nonperforming loan level would have declined by $6.7 million. Other real estate owned and other repossessed assets are down $1.9 million for the third quarter. This places our ratio of nonperforming loans at 1.62%, as well as our ratio of nonperforming assets at 1.62%.

As disclosed in the second-quarter 10-Q, we were carefully monitoring the $13 million loan that was current and accruing. In the earnings release, we stated that in the third quarter we made the decision to move this loan to nonaccrual status, and to record an impairment of $2.2 million. While still current, we believe the company will be unable to continue to make payments after December 31. The uncertainty surrounding the timing of the collection of our principal and interest led us to the impairments and nonaccrual decision. The company is currently in the process of assessing alternatives to reduce its loan to a more workable level.

Provision expenses elevated this quarter, at $5.1 million versus $1.9 million in the second quarter. $1.1 million of this provision relates to our consumer finance company, Citizens Finance. The provision year-to-date for Citizens is $2.8 million compared to the $1.6 million for the first nine months of 2012. Half of this increase covered additional charge-offs in 2013 as compared to 2012, while the other half relates to increasing the allowance due to the increase shown in the historic loss. The remaining provision expense was a result of $2.2 million for the impairment on the loan mentioned earlier, with the remaining associated with the allowance needed for new loan growth, net charge-offs, and loan migration within past categories. 2012's provision expense was positively impacted by the successful recovery of loans previously charged off.

The first nine months of 2012 resulted in total recoveries of $5.7 million as compared to the $3.3 million received in the first nine months of 2013. I have mentioned in earlier calls that the higher level of recovery in 2012 was not expected to be sustainable at those levels. Even with the increased charge-offs this year at Citizens and the production in recoveries on loans previously charged off, our ratio of net loan charge-offs to average loans and leases is at 20 basis points for the quarter, and at 24 basis points year-to-date; with nearly half of this attributed to the consumer finance company.

As stated in the earnings release, 30- to 89-day delinquencies increased from 29 basis points at the end of the second quarter to 67 basis points at September 30th. This increase was mostly associated with a single credit. The borrower was waiting for certain sales proceeds which reduced the indebtedness by over $2 million. This credit was subsequently renewed after quarter-end. Had this transaction occurred prior to quarter-end, our 30- to 89-day delinquency would have been at 0.37%.

Other real estate owned continues to sell at or near book value. Net loss on repossessed assets was $1.1 million this quarter. $731,000 of this is collection, ORE, and repo expense. The remainder was associated with property value adjustments during the quarter. $3.4 million in sales were recorded in the third quarter. Our existing portfolio is made up of 25 residential properties, aggregating $2.6 million; and 87 commercial properties that aggregate $30.4 million. Of the 87 properties, 28 are individual lots and 26 are land loans, combined comprising $17 million of our other real estate owned.

We have been successful in liquidating many of our ORE properties. In September we closed on 17 individual properties, many of these individual lots -- many of these were individual lots, so the aggregate dollar of sale was not that great, but the movement of properties was very encouraging. Currently, we have 26 properties contracted to sell for an aggregate reduction of $13 million, or 39.3% of our total ORE assets. As shown in the earnings release, our coverage ratio of allowance for loan and lease losses as a percent of nonperforming loans and leases was 87.73%, down from the second quarter of 91.74%.

We had an increase in nonperforming loans at each of the past two quarters as a result of four larger loan relationships. I expect that at least one-third of the balance of these four loan relationships will be resolved by the end of this year, with the remainder in the foreseeable future. The reduction of nonperforming loans will result in an improvement in this coverage ratio.

The allowance for loan and lease losses as a percent of loan and leases increased from 1.33% to 1.42% this quarter. This is primarily the result of an increase in the allowance held for impaired loans, specifically the loan mentioned earlier. It should also be noted that evaluation reserve of $2.3 million is recorded for those loans obtained in acquisition. Excluding those loans from the allowance per loan and lease losses as a percent of loans and leases calculation would result in a ratio of 1.47% for September 30, which would compare to 1.38% for June; 1.41% for March; and 1.45% for December 31.

All of our banks completed their annual examinations from the FDIC and our respective state examination teams during the past quarter. These examinations went well, as we expected, with no significant changes noted in classified credits or other noted weaknesses or recommendations.

With that, I will turn the call back to you, Lynn, and remain available for questions.

Thank you, Ken. We will now open the phone lines for your questions.

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions). Jeff Rulis, D.A. Davidson.

Thanks. Good afternoon. I'm trying to get a handle on the pretty good visibility, or the discussion on the gain on sale. But on the servicing side, you continue to comment that you're set up for an increase in the purchase side of business. I guess looking at that loan servicing line item of $4 million this quarter, could you comment on the confidence of maintaining or maybe even growing that line item going forward, relevant to the trends on mortgage that we are seeing?

I think, Jeff, the mortgage servicing book should remain relatively flat; and, therefore, I think our servicing income should remain constant, as well going forward. [Why with] the change is the gain on sale. That's the one that's sensitive to new production and what is going on in the sales market.

Sure. And based on the margin trends, a pretty big drop on the gain on sale, quarter-to-quarter. Any sort of rough outline, maybe even a 2014 figure? I mean, that's a little far out, but any sort of estimate on that impact going forward?

No, we're in the process of doing our budgets right now for next year, so we really don't have a good handle on that. There's lots of things that go into that gain on sale line. There's mark-to-market on the pipeline, and there's various other things. So it's really a tough number to get all the components surrounding it.

Yes, Jeff, in addition to that, a lot depends on where interest rates go. Obviously, it depends on the amount of mortgage LOs and how productive they are in both our existing and new loan production offices. So just so many different things feed into that. Our hope is that we can continue to add good, productive, purchase MLOs. If we can do that, we should see a reasonably nice increase in production, albeit probably lower margins if rates start to climb. It will be interesting to see.

On the $13 million loan brought on on accrual, what type of -- a little more color on what type of a loan it is; and are there others in the portfolio similar? Any other additional detail on that loan, or geographically, or that type would be helpful.

The earnings release said it was to a bank holding company. But we'd like to keep any more detail other than that; and know that there would be no others in the portfolio, say, that are similar, that could become problematic.

Okay. And maybe just one last one for Bryan. On that margin outlook you gave, does that include the impact of Morrill coming on, in terms of the loans and securities that are brought over?

No, it would be our own book. I think Morrill's net interest margin coming in is a little bit lower than ours, so that may pull down a bit. But we've got a lot of purchase accounting and things that will be flowing through there as well, as we draw the mark. So, that will be a change from what I said.

Okay. I'll step back. Thanks.

Michael Perito, KBW.

Hello. Good afternoon, guys. Stepping in for Chris. I had one more question on the mortgage line. You mentioned in your prepared remarks about the expense benefit this quarter. Are you expecting additional benefit if activity remains depressed in the salaries and benefits line going forward?

Yes, I think there might be a little bit. Certainly, the commissions should stay down if activity doesn't pick up. We have addressed some of the closing and underwriting staff that we have. So some of that benefit, I think, could come through next quarter as well.

Okay. And then a question on the securities book, can you help me -- do you guys think about it from a dollar amount perspective, or a percentage of earning assets? And, going forward, should we assume that the dollar amount will stay flat, and just as the loans grow, it will shrink as a percentage of earning assets? Or do you think the dollar amount will actually shrink going forward as well?

Well, we're more accustomed to running, in normal times, normal interest rates were like 20% of our assets are in the investment portfolio. As you know, we've been running closer to 30%. We do have that $20 million cash flow coming off. And with interest rates dropping back down again, with the 10-year down around -- I think it was that 249 today. We may take some more of those investments and sell them off. But a lot of it depends on our ability to generate quality loans, because it is either going to be in loans or investments. And we prefer to have it in quality loans, but we're not going to give up on quality, and we're not giving up substantially on price either. So the pipeline looks strong, so I'm hopeful we'll show another good quarter of loan growth. If that's the case, we'll be able to chew up that liquidity at $20 million per month coming off the investment portfolio.

I think the other thing, Michael, as you think about the numbers that I said that Morrill & Janes will come in at, they've got a fairly high percentage of their assets in investments. So that number will probably pick up for us a little bit here when we add them in. But, again, we'll probably have the same philosophy to work that book down, and hopefully reinvest those dollars in loans, as well.

Okay. And then, one last one for me. The reserve was about 1.4% at quarter-end, and there was obviously some one-off things in the provision this quarter. So any more color on how you guys are thinking about the provision and the reserve going forward, especially within the context of the continuing organic loan growth?

First, as I have put a little more color on my comments this quarter about our consumer finance company, I want to make sure that nobody loses sight of them. And they do have a higher loss percent than the banks do. So they have a normal loss rate running of about 4% for that portfolio, which now runs at -- just under $70 million of our consumer loans come from the consumer finance company.

I don't see any major losses in an upcoming quarter. We did see the tick-up in the allowance based upon that impairment, as I mentioned. If we can resolve past that problem, that will come back out of there. But I think you can look for new loan growth. As Bryan and Lynn both mentioned what we expect for loan growth, you probably look at 1.3, 1.35, on new loan growth. You can certainly look at moderate losses; as I mentioned, through the first nine months we were at 24 basis points of net losses. I would think that's a realistic number for us for the year, as well. Hopefully that gives a bit of guidance.

Okay. Thanks, guys. Thanks for taking my questions.

Brad Milsaps, Sandler O'Neill.

Hey, good afternoon. Ken, I appreciate the color on the bank holding company loan. Just curious -- did that come out of the TDR bucket? It looks like those were down quite a bit on a linked quarter basis. And I apologize if I missed that in the color you were giving; I was kind of writing quickly. So I'm just kind of curious on the movement there.

Yes, we had moved it to TDR in the second quarter, and then we moved it to nonperforming in the third quarter.

Okay. Great. Just wanted to follow up a little bit more on the mortgage business. I guess in the last day or so there was a release out from another company, maybe taking away some of the senior leadership you guys had at that part of your business; just any comment on that. And would most of the lenders that you've hired over the last 18 months -- are they subject to some type of non-compete, or do you have them tied up for some certain period of time, to where you could hopefully retain some of those folks as the business gets a little bit weaker here?

We do have a non-compete with our mortgage LOs, Brad. One of the things that -- we felt bad that Jeff was going to pursue something other than what he was doing with us, obviously. But one of the things we were very pleased about is that Jeff did a nice job of building a succession behind him in the key areas, and we're really pleased with the kind of talent that is there to carry on the day-to-day.

And, of course, we had Doug Horstmann and Dave Horstmann both at the holding company level, along with our finance people spending a fair amount of time on that mortgage piece. So we kind of had it handled from both sides. So you always get some disruption when your president of your group leaves. But we have five candidates we're looking at. I think we've narrowed it down to two. And we are pleased with the talent that we were able to identify to replace Jeff. And I'm hopeful that in the next 30 days to 45 days, we'll have a new president in place for Heartland Mortgage.

Okay. That's great color. So the loan officers you do have -- they would be subject to some type of six months or year non-compete situation if they were to try to pursue something else?

It's a non-piracy agreement that all of our people signed. Is not exactly a non-compete. We can't keep them from following their occupation, but it's a non-piracy agreement. I really think that we feel pretty good about our regional sales managers, as well as our national sales manager. They've stepped up and done a nice job in some pretty challenging times, really. So I think we feel pretty full good about the group.

Absolutely. I appreciate you answering my question. Thank you, guys.

Jon Arfstrom, RBC Capital Markets.

Thanks. Good afternoon, guys. Hello, Bryan. Welcome. A question on your gain on margin guidance. You talked about lower margins. Were you talking about compared to a year ago, or lower compared to what you saw in Q3?

Actually, that was a Q3 drop from Q2. It dropped pretty significantly. Several other banks also had a similar thing happened to them.

And when you were talking about Q4, you were talking about lower versus Q3.

Yes, I would say probably closer to what they were in Q3 than going a whole lot lower. But we'll see.

Okay. That's helpful. And then as long as I've got you, anything on the tax rate other than what you mentioned as just the lower income and the higher tax exempt income?

No, I think that's why the rate dropped so much this time. It should come back as, hopefully, our earnings normalize to a little bit higher level.

Okay. And then, Lynn, on the loan growth number, your full-year guidance is a little lower than what you talked about last quarter for the full-year guidance. You still had a good quarter, but I'm wondering what changed. Is there anything in your mind that caused that number to come down a bit?

Well, as you know, Jon, we started out in a hole. First quarter, we went backwards by about $41 million. Second quarter, we made all of that back, plus about $11 million; and then $69 million plus this quarter. So we have not done a great job of forecasting our net growth. What we've experienced is pretty good amortization and payoffs, low usage on lines of credit. And we have some modeling that we're going to use on a go-forward basis to do a better job of forecasting that net number. I really feel pretty good about the way the pipeline looks now, and now that we've got a better handle on the usage on our lines, which is pretty darn low -- about 40% usage.

You've got a commercial banker that books a $2 million operating line, and the usage on it is $750,000 to $1 million. We haven't been very good at projecting that. I think we've got a better handle on that going forward now, so we'll be able to give you a little better guidance on the loan growth. But at present, the pipeline looks pretty good for fourth quarter. And I would hope that it would be at least as good as what we've showed you for the third quarter.

Okay. That's helpful, because it is a good number, but it's a little less than we thought for the full year.

Absolutely.

Yes. And then, Ken, just one question on the big credit. You talked about a $2.2 million impairment reserve. Is there anything else against that, in terms of specific reserves? Or is that it, at this point?

No, it didn't layer anything in there, as we can't. It's just that $2.2 million impairment.

Okay. All right, thank you.

John Rowan, Sidoti & Company.

Good afternoon, guys. When you look at the $20 million of cash flow that is going to pull out of the securities portfolio and into loans per month, what does that do to your capital ratios on a quarterly basis? Is it net neutral? Does it actually improve your leverage? I just want to understand if that's going to have an impact.

It shouldn't have much of an impact on the capital ratio -- the leverage ratio. It had a little impact on our -- maybe our risk-based assets; and, therefore, it could be a slight decrease in our regulatory capital, but that should be the impact.

Our risk-based capital ratios are way, way up there; way in advance of where they need to be. So really the only capital ratio that isn't over the top in good shape would be -- the tangible common is a little light, still. And when we add in Morrill & Janes, I think we figured that would take it down 20 bps, to 25 bps, max. So it will be a little bit of a reduction in our TCE. But other than that, the rest of those capital ratios are really, really strong.

Okay. Just be clear -- the $2.2 million impairment for that large loan; that's in the provision expense, correct?

Yes, it was.

Okay. And then just one last question. So, Citizens finance, obviously it seems like there was some weakening there. You have $70 million of loans to this business. Which loan categories are you seeing the problems? And obviously, as far as I know, Citizens does auto loans. They do debt consolidation, personal loans. Is there a specific portion where you're seeing pressure in that business?

Almost all of our loans up there are automobile secured. The weakness came in one of the newer branches that was opened, and got a little bit deeper than what we should have with the dealer relationship. We just had more losses in one of the branches than what we expected. But that's pretty well turned the corner. We've shrunk that back a couple of million. So it wasn't a systemic problem, as to the type of business we're in. We got into it a little bit with of an unknown in one of the markets.

Okay. Thank you very much.

Daniel Cardenas, Raymond James.

Good afternoon, guys. Quick question on the deposit side. Are you seeing any pricing pressure materialize in any of your markets?

No, really have not. Part of it is that if we have single service CD clients, we're not going to price up to hold those. We clearly want to have a full relationship on the deposit side as well as on the loan side. So if somebody wants to outbid us, i.e., a credit union, which would be more typical than anything, we'll let that single service CD go. We do give our people some latitude to price up a little bit on the CDs when we have a full relationship. But I really don't see a lot of pricing pressure other than from some of the markets where there is aggressive credit union pricing. But we're not following them up.

And then as I look at the loan portfolio, has there been any shift in the average life in the extension of the duration of the average life of the portfolio?

We get a little bit of requests for fixing loans for five years. If there's any size to those loans, we'll typically put a swap in place to swap it back to variable. So I think you're going to continue to see some pressure to move that out, but it hasn't been substantial at this point. I've kind of been expecting it. We haven't seen a huge increase in duration at this point.

I think the only thing I'd add to that is we did see a little growth in the mortgage line item. There is probably a little bit of extension in there, as those tend to be slightly longer. But it's not a significant growth, so it is probably not changing significantly the duration of the portfolio.

Most of the mortgage ARM product that we would throw in the portfolio would be 3/1 and 5/1 ARMs.

And 45% of our commercial loan production or renewal year-to-date has still been in variable-rate production.

You guys are -- still some appetite for additional M&A. I missed your comment, Lynn. When you were talking about that, did you say you were looking to try and do -- eke one more deal before year-end?

I can't commit to that, but we would certainly like to. I've said that, I think, in the last couple of releases; we would like to announce at least one more yet this year. Some of these things take a little longer time than you would hope.

And has there been a pickup in people calling you?

I don't know if there's been a pickup in people calling us. But we call on an awful lot of banks, trying to position ourselves with banks as the preferred partner. And that pipeline is still very, very strong; so, a lot of opportunities. And as I've said in the past, if we were just in the state of Iowa, there wouldn't be as many opportunities. But the fact that we're in the number of states that we're in -- we see opportunities in almost every state. I'd say the only state that doesn't seem to have a lot of opportunity left in it would be Arizona; it's pretty well picked over.

And then just one last question. In terms of seller expectations, have they been shifting away from you guys?

You mean, as far as price expectation (multiple speakers) the seller?

As far as price expectations -- have they been inching higher, or still fairly stable with what you've seen the last few quarters?

Yes, we do see some of the people we talked to wanting to get more in the area of 1.5. There are still opportunities out there, between book and 1.25. The reason that we like to have a deep pipeline is that we can pick whichever transaction either meets or exceeds our IRR or our accretion guidelines. So if it gets too expensive, we just pass on that and wait it out. I do see deals parting falling apart, Dan. That's kind of an interesting -- where expectations were to pick up something like 1.5, and we just couldn't get there so we passed on it, and then find out later that the deal fell apart.

Okay. Great. Thank you.

Jeff Rulis, D.A. Davidson.

Thanks. Sorry guys, just a couple of housekeeping items. Ken, you mentioned that one-third of the balance you expect to be brought on accrual by year-end. Of the four loans, what was the total balance on that?

I talked about the four larger loans that we had taken nonaccrual in the second and third quarter. Those four aggregated $28 million.

Great. Okay. And then just confirming that coupon on the SBLF. That adjusted higher in Q3, just sort of a one -- basically, the guidance is that that falls back down to the Q2 level, what you paid.

I think there is a slight catch-up adjustment that we had to book this quarter. It should go back down to what you saw in the second quarter.

Great. Okay. And then on the Morrill balances that you quoted at the $380 million that came over, that was as of the acquisition -- it's a little bit up from announcement day, so they're putting on some decent growth?

Yes, they've been putting on a little bit. I think that's actually pretty close to their 9/30 number.

Okay. Okay, that's it. Thanks.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Mr. Fuller for closing comments.

Thank you. Well, in conclusion, Heartland's third-quarter earnings performance, while falling short of our expectations, did offer several areas of promise. And they would include an improved net interest margin, continued improvement in deposit mix, a continued positive trend for loan growth, and a double-digit return on equity year-to-date. Finally, we completed the purchase of Morrill Bancshares, adding to the Heartland family a very high-quality banking company with nearly $800 million of total assets.

We continue to be well positioned, and eager to pursue acquisitions that are accretive to earnings and meet and/or exceed our M&A criteria. So, in short, I feel very good about the earnings power of our Company, and continue to see excellent opportunities ahead.

I'd like to thank everyone for joining us today, and hope you can join us again at our next quarterly conference call, which will take place on Monday, January 27, 2014. Have a good evening, everyone.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.